SPIVA Spikes Mutual Fund Managers Again

Standard and Poor’s has been meticulously documenting mutual fund returns for the past decade and comparing them to appropriate indices. The latest results are now available in the bi-annual SPIVA Scorecard. I don’t know how much S&P earns from doing this research, but I believe that active fund managers would pay a hefty sum not to have this information in public hands.

The tenth anniversary of the SPIVA Scorecard is more bad news for mutual fund managers who try to beat the markets. They’re just not doing it; not anywhere, anyhow, or anyway in any asset class, sector, or style. This is the harsh reality of actively-managed fund results, and one more reason to own a diversified portfolio of low-cost index funds and ETFs.

The SPIVA report states in unabashed language that, “There are no consistent or useful trends to be found in annual active versus passive figures. The only consistent data point we have observed over the five-year horizon is that a majority of active equity and bond managers in most categories lag comparable benchmark indices.”

It’s not supposed to be this way, according to mutual fund mythology. Wall Street representatives say that talented mutual fund managers rule the markets in every way. They’re lying.

First, it is widely believed that active management outperforms during difficult times. The perception is that fund managers will “get you out” of a bad market and reinvest in a good one. S&P analyzed the relative performance of active managers during the two bear markets since the Millennium, which encircled two recessions, two wars, a global financial crisis and the European sovereign debt crisis.

If what Wall Street says is true, then the SPIVA Scorecard would have clearly showed that active managers missed the bad periods over the past decade. But it is not true. It’s a myth. The claim that active managers can successfully time markets isn’t even close. The truth is that a majority of active fund managers performed badly in bad markets and good markets.

A second myth perpetrated in the marketplace is that index funds work well in large, institutionalized markets and that active management works best in smaller, inefficient markets. In fact, a common investment strategy used by advisors is “core and satellite” where a core position is held in low-cost index funds and encased by actively-managed funds intended to add value.

Nothing in the SPIVA Scorecard suggests that actively-managed “satellite” funds perform better than the indices they are trying to beat. The data shows that active funds underperform without prejudice to asset classes, sector or style. When active funds do win in a style category, it’s not by much and not for long.

A third noteworthy highlight of the SPIVA Scorecard is the unusually large number of active funds that disappear or shift styles. Over any 5 year period, about 25 percent of equity funds and 15 percent of bond funds disappeared through merger or closure. About half of the remaining equity funds changed style over the period, while most bond funds remained in their style. It’s harder to mess up a bond fund.

The SPIVA Scorecard does a great job breaking out the percentage of closures, style changes and underperformance in each mutual fund category, but it doesn’t tell us how well a diversified portfolio of actively-managed mutual funds would have performed. I can tell you that. The odds are so incredibly low that a portfolio of actively-managed funds will outperform a portfolio of index funds over time, that it’s almost criminal for Wall Street to infer that there is any hope. Please refer to my latest book, The Power of Passive Investing [Wiley, 2011] for a review of active fund portfolios to passive fund portfolios.

The SPIVA Scorecard has so many “Wow! You’ve got to be joking,” moments that I can’t possibly fit them all in one article. You’ll have to download the report and read it for yourself. If you don’t have at least 10 “wow!” moments, then you’re probably an active mutual fund manager and you already know how bad things are.